On Friday afternoon, Governor Chris Christie announced his intention to pull New Jersey out of a tax reciprocity agreement with Pennsylvania. If Christie does end the tax deal, it could prove devastating for the city’s budget.
Following a 2015 Supreme Court decision, Comptroller of the Treasury of Maryland v. Wynne, local income taxes on a resident’s income earned out-of-state are unconstitutional under certain circumstances.
The problem arises when a state or locality attempts to tax income earned in another state that also taxes the same income. That leads to double taxation, putting an undue burden on cross border economic activity and violating the Constitution’s Commerce Clause, which gives Congress exclusive authority to regulate interstate commerce.
Philadelphia’s wage tax, levied at 3.91 percent on residents regardless of where they work and 3.4 percent on non-residents who work in Philadelphia, is nearly identical to the tax scheme declared unconstitutional in Wynne.
Like Wynne’s problematic county income tax, Philadelphia’s city wage tax has the potential to place a double tax on residents who pay income taxes to another state. Until now, that hasn’t been a major issue: Just seven Philadelphia residents had challenged their local tax bill as of May. That’s because most Philadelphia residents only pay income taxes in Pennsylvania, thanks to tax reciprocity agreements with Maryland, Ohio, Virginia, West Virginia, Indiana, and, for who knows how much longer, New Jersey.
Those agreements allow residents to pay taxes in their home state first and to receive a credit against income taxes in the state they work in. In the event that the credit from paying the home state taxes does not cover the full tax bill in the employment state, then the taxpayer pays the difference. Those reciprocity schemes allow the city wage tax to sidestep the issue of two different states taxing the same income.
If Christie follows through and ends the tax reciprocity agreement, which has been in place since 1977, Philadelphia residents working in New Jersey would be forced to pay New Jersey income taxes first, instead of Pennsylvania. They would then get a credit for what they paid the Garden State against their Pennsylvania taxes. Pennsylvania has a flat 3.07 percent income tax, whereas New Jersey taxes from 5.53 percent to 8.97 percent on income from $40,000 and above.
With the reciprocity agreement gone, Philadelphia residents working in New Jersey would also then be entitled to a credit against the Philadelphia income tax, which for Constitutional purposes functions the same as a state income tax. When two states try to tax the same thing – here, a Philadelphian’s income, in the form of the city wage tax (effectively, a Pennsylvania tax) and the New Jersey income tax – it’s considered double taxation that unduly burdens interstate commerce and violates the dormant commerce clause.
Depending on the Philadelphian’s income and taxes paid to New Jersey, they could see some or all of their city wage tax burden disappear. Given that those same residents would still end up paying more taxes to New Jersey, it wouldn’t be much of a net gain for most, though, and the highest income individuals would still pay more.
Philadelphia’s budget, however, could face ruin. According to the Delaware Valley Regional Planning Commission’s (DVRPC) 2012-2013 Household Travel Survey, 34,500 Philadelphia residents commute to South Jersey for work—about 5 percent of working Philadelphians. However, that figure only includes Philadelphians who work in four New Jersey counties—Burlington, Camden, Gloucester and Mercer—so the actual number may be higher still.
To give a rough estimate of what the potential impact might be: Even if just 34,500 taxpayers would be effected, using the city’s median household income of $36,836, and assuming a full credit for the 3.91 percent city wage tax, Philadelphia could lose $49.7 million a year in revenues.
In Maryland, the Wynne decision cost Maryland counties $42 million a year in revenue. Maryland has tax reciprocity agreements with Virginia, West Virginia and Washington, D.C.
The news of Christie’s decision broke late on the Friday of a holiday weekend. A spokesman for the Kenney Administration said officials are still reviewing the matter.